May 9, 2011
By playing hardball with the French and Germans this weekend, Greece has bravely sparked a liberation which could topple the eurozone as we know it – and not a minute too soon
If you have ever tried to learn German, you will know that reading it is much more difficult than speaking it. The problem is the sentence construction, and the fact that the verb generally comes at the end of the sentence. So you spend ages trying to read practically backwards – or at least this particular grammatically-challenged student did.
Like all languages, after awhile there comes a time when your teacher gives you articles from a local paper to see if you can make out what is going on. I just about understood what the mass-market Bild was saying, but the real challenge was to figure out what was written in Der Spiegel.
In fact, German friends of mine used to joke that Der Spiegel was so highbrow and its readership so well-educated that even they had difficulty understanding the grammar it used. Der Spiegel uses the German of Schiller, Goethe and Heine. It is Germany’s paper/magazine of record, not given to running stories without foundation.
Its credibility has been bolstered in recent weeks because it has clearly been getting accurate leaks from German government sources about the thinking both in Berlin and Frankfurt.
Therefore, the news published late last Friday afternoon in the online version of Der Spiegel, that Greece would leave the euro this weekend, caused the markets to react violently. The euro has plummeted against a feeble dollar. The German leak stated that certain eurozone finance ministers – the ones from the richer countries – were meeting this weekend in the exclusive surrounds of ChÃ¢teau de Senningen in Luxembourg, with the Greeks indicating that, if they didn’t get a deal on their debts, they would pull out of the euro. The usual denials followed the rumours, but it is clear that the Greeks are playing hardball – and good on them.
The Greeks know that, like us, their debt is unsustainable and that there is no way they can avoid default. They also know that their economy can’t take more austerity. Greece has already missed some IMF targets, and will miss more. The markets decided months ago that the Greeks would default – the issue for investors is how and when, not if. The same goes for us.
The Greeks also know that the one thing the Germans and French – particularly the French – don’t want is a ‘conditional’ euro, where commitment to the currency is conditional on whether it suits a country or not at a certain time in the economic cycle. The idea that a country could pull out is anathema to the French and German establishments, but this is exactly where their banks’ reckless lending to the likes of Greece and Anglo Irish has led us.
Anyone who has any knowledge of economics realises that a strong currency makes a weak economy, like Greece’s, weaker. We also know that, when debt can’t be paid, it won’t be paid. We also know that a balance sheet like Greece’s, which is carrying too much debt, is never made stronger by yet more debt. It is made stronger by less debt.
There are only two ways you can lessen debt. The first is when the economy grows strongly, generating the tax revenue to pay off all the debt without much effort. This clearly will not happen in either Greece or Ireland. The other way is when you do a deal and default.
Obviously, this is what the Greeks will do this weekend and, just to focus the minds of the rest of Europe, they have indicated that, if they don’t get a deal, they are off and will introduce a new drachma and leave the outstanding debt issues to the lawyers to sort out who gets what and when.
How would bringing the drachma back help them? First, they would announce that, from tonight, one new drachma is equal to one euro, and all former euro debts will be paid in drachmas at the prevailing exchange rate. At the moment of recalibration, all the old euro debts are to be paid in drachmas which, at that moment, have an exchange rate of one to one. So all the old euro debts are converted to drachma at an immediate exchange rate of one to one. So no default yet.
Then, they will announce that the drachma will be a free-floating currency. The currency’s value will fall like a stone, possibly by as much as 70 per cent. This will wipe out much of Greece’s debt problem at a stroke. But it’s not that simple, because the people who are owed money by Greece will be livid – and will demand payment.
The Greeks will have figured out in advance how much is owed by foreigners and how much is owed by locals. They will clearly be keener to default on foreigners than locals. This is what the Russians did in 1998,whenRussia defaulted on rouble-denominated debt, knowing that foreigners – greedy for yield – had bought up the rouble-denominated debt. The Russians roasted the foreigners and gave the lawyers headaches.
The same would happen if Greece pulls out of the euro – a prolonged legal battle between creditors and Athens would ensue. The Greeks would then print the new currency and inflation would rise, resulting in a greater haircut being taken by the creditors because, the higher the Greek inflation, the more the drachma would fall and the more the creditors would lose.
Greek banks that hold Greek government debts would see the ‘drachmasation’ of their assets, which would undermine greatly the value of these banks in euro terms. However, in terms of the currency they lend in, the change would not be that huge.
Middle-class Greeks would take all their money out of the country and this money would wait offshore until the crisis settled down. The government would probably have to enforce capital controls for a time to make sure that it could have some control over where the currency went.
It would be chaotic but, like the Asian Tiger devaluations, it would pass and the country would recover. The economy adjusts. If you think the like of this is unusual, it is not. This is what Finland and Sweden did in 1993.They both sacrificed the interests of their creditors – both local and foreign – for the long-term interests of the economy. And it worked.
The competitive gains that both Finland and Sweden enjoyed from devaluing their currencies in 1992 lasted well into the 2000s.The British are regularly at the same game.
The difference in devaluing your currency and leaving a currency union is one of perception. The former is not likely until it happens and then life goes on; the latter is inconceivable until it happens, and then life goes on.
The country becomes more competitive, holidays in Greece are cheaper, exports from Greece are cheaper, the Greeks will price assets in euro for a while – this is a process which will be known as ‘eurosation’ and is already a reality in most Balkan countries anyway.
For example, if you want to buy an apartment in Croatia or Serbia, the price will always be given in euro, and never in kunas or dinars.
The crucial thing is the currency of the country is now appropriate to the country. A much weaker local currency reflects the weakened economy and we start again. Imports are expensive, which they should be, and exports are cheap, which they also should be. Like in Iceland, interest rates would fall rapidly, and off we go.
By threatening to leave the euro, the Greeks have called the Germans’ bluff. The Germans were playing hardball with the Greeks, and now the Greeks have turned the tables and indicated that they are prepared to push the nuclear button, having decided that the fallout will be felt more abroad than at home. Nothing will focus the minds like this threat. The process of orderly default can now happen in the eurozone.
For Ireland, the one thing we can say with an element of certainty is that this weekend marks a liberation. Once the Greeks are given permission to default by the Germans, we will be next. The bondholders will not be paid, pure and simple.
This is obvious, no matter what language you speak. Some truisms are so clear that they never get lost in translation, even in Der Spiegel.
David McWilliams and Professor Joseph Stiglitz will be speaking at www. zeitgeistminds.com on May 16,on the future of the euro and the European periphery states